DP15488 Public Debt as Private Liquidity: Optimal Policy
|Author(s):||George-Marios Angeletos, Fabrice Collard, Harris Dellas|
|Publication Date:||November 2020|
|Keyword(s):||optimal policy, piblic debt, private liquidity|
|Programme Areas:||Macroeconomics and Growth|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=15488|
We study optimal policy in an economy in which public debt is used as collateral or liquidity buffer. Issuing more public debt raises welfare by easing the underlying financial friction; but this easing lowers the liquidity premium and increases the government's cost of borrowing. These considerations, which are absent in the basic Ramsey paradigm, help pin down a unique, long-run level of public debt. They require a front-loaded tax response to government-spending shocks, instead of tax smoothing. And they explain why a financial recession, more than a traditional one, makes government borrowing cheaper, optimally supporting larger fiscal stimuli.